Michael J. Wilson, Morgan Stanley’s chief U.S. equity strategist, and CIO argued stocks still have further to fall before hitting their bear market bottom.
“We remain confident that lower prices are still ahead,” Wilson wrote. “In S&P 500 terms, we think that level is close to 3,400, which is where both valuation and technical support lie.”
If Wilson is correct, his price target means the S&P 500 still has a roughly 15% drop ahead of it from Monday’s levels. However, the strategist wrote that he expects the index will recover to 3,900 by next spring, even as market volatility continues. While a year of flat trading won’t exactly be music to the ears of ailing stock investors, it’s better than the current trend.
On Monday, Wilson argued that the “risk of a recession has gone up materially,” and Morgan Stanley’s bear case now assumes the U.S. will fall into a recession by 2023 due to “sticky” inflationary pressures and sustained margin declines, and a broad deceleration in sales growth.
It’s not the only investment bank worried about a recession. Deutsche Bank has said it sees a “major” recession hitting the U.S. economy by next year, and former Goldman Sachs CEO Lloyd Blankfein argued the current recession risk is “very, very high” in a CBS “Face the Nation” interview on Sunday.
Also, Goldman Sachs figures things could get worse. Much worse.
In a note to clients, the investment bank’s equities team calculated twin full-year forecasts for the S&P 500.
The base case is for the benchmark to close out 2022 at 4,300, a near-7% premium over Friday’s close. This assumes Corporate America will be able to eke out profits as they adapt to a coming slowdown.
The worst case is far bleaker. It involves a full-on recession slamming the U.S. economy, and that would mean stocks falling a further 10% to close out 2022 at 3,600.
Lloyd Blankfein, Goldman’s former CEO, and current senior chairman appears to be banking on the latter scenario. On Sunday, he told a Face the Nation interviewer that there’s a “very, very high risk” the American economy will slump into a recession.
The pessimistic calculations are adding further volatility to a risk-off market.
Economic growth has slowed, shrinking 1.4% in the first quarter, and stocks have taken a hit as tech and growth names continue to be repriced for a new, more hawkish, era of Fed policy.
When Morgan Stanley’s report was first published, the S&P 500’s price-to-earnings (P/E) ratio was 21.5x, higher than at any point in history other than the dot-com bubble. The investment banks’ economists predicted it would fall to 18 through the first half of the year, and again, they hit the nail on the head as the index is currently trading at around 17 times earnings.
But now, the Morgan Stanley team sees valuations falling even further before the current stock market pain comes to an end, arguing earnings guidance is likely to disappoint through 2022.
“The bottom line is that this bear market will not be over until either valuation fall to levels (14-15x) that discount the kind of earnings cuts we envision, or earnings estimates get cut,” Wilson wrote.
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